This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the top of any article.

EU Looking to Impose Capital Buffer on Money-Market Funds

Plan would allow money funds to retain a stable NAV, but would impose new capital requirements on those that do.

Banks and asset managers running money-market funds may be forced by the European Union to raise capital buffers and hoard easy-to-sell assets as part of a regulatory push to tame the $4.7 trillion global industry.

Michel Barnier, the EU’s financial services chief, said such buffers would have dealt with most difficulties suffered by fixed share-price funds in the wake of the 2008 financial crisis, as he rejected calls for an outright ban from German Finance Minister Wolfgang Schaeuble, his French counterpart Pierre Moscovici and a group of EU regulators.

Money market funds “are not always stable, and in a period of tension they can threaten the financial system, including the banks,” Barnier told reporters in Brussels. He said “a formal and brutal ban” of fixed share-price funds sought by some regulators was unnecessary and would hamper investors.

Regulators have sought tighter restrictions on money-market funds since the September 2008 collapse of the $62.5 billion Reserve Primary Fund. Its failure, caused by losses on debt issued by Lehman Brothers Holdings Inc., triggered a wider run on the industry that helped freeze global credit markets.

Barnier set out plans to toughen regulation of the funds as part of a broader push to rein in a shadow banking system that he said could pose a threat to stability if left unchecked.

Money funds act as intermediaries between shareholders seeking liquid investments and borrowers seeking short-term funding. They typically invest in money-market instruments such as commercial paper and government debt.

Cash Buffer

The EU plans include requiring funds that maintain a fixed share price to build up a cash buffer equivalent to 3 percent of their assets, according to the statement. Funds that are already in place before the rules become law would have three years to fully meet the requirement.

The European Systemic Risk Board (ESRB), a group bringing together central bankers and other regulators from the EU’s 28 nations, has advised that fixed share-price funds be banned owing to a susceptibility to runs and interconnectedness with other parts of the financial system.

ESRB recommendations aren’t orders that must be accepted without questioning, Barnier said.

“I’m not declaring war on these funds,” he said. “I want them to be well supervised and well capitalized.”

Barnier’s stance runs counter to a tougher position taken by Schaeuble and Moscovici in a joint letter they sent to him this week.

The ministers called in their letter for the ESRB guidelines to be implemented in their entirety, Martin Kotthaus, a German finance ministry spokesman, told reporters in Berlin today.

Barnier’s proposal “falls short” of recommendations by EU and international regulators, Kotthaus said. “Germany wants stricter rules than those proposed by the EU.”

The European Fund and Asset Management Association, a group representing the investment management activities of banks including HSBC Holdings Plc and JPMorgan Chase and Co., has warned that setting capital requirements for money funds risks destabilizing their business model and confusing investors, who may simply look elsewhere.

“Instead of seeking ever more areas to regulate, we should ensure that we are focused on tackling the root causes of the crisis—including the state’s implicit guarantee of the financial system’s biggest banks,” Syed Kamall, a U.K. Conservative lawmaker representing London in the European Parliament, said in an e-mailed statement.

“The commission is sweating over building a mousetrap when there’s a tiger on the loose.”

Share Prices

Under the draft EU plans, funds with either fixed or floating share prices would face limits on the timespan of their investments and minimum rules on diversifying their portfolios.

Funds would be forced to hold at least 10 percent of their assets in instruments that mature within a day, and 20 percent in securities that mature within a week.

Some of Barnier’s proposals “do not seem particularly well suited to Europe’s reality,” Guido Ravoet, chief executive officer of the European Banking Federation, said in an e-mail.

“It is important to strike a sensible balance between the need for greater transparency for investors with increased stability on the one hand while retaining MMFs as important providers of short term funding for banks, companies and public authorities,” he said.

The draft EU rulebook would also limit the assets that funds can invest in, and ban them from activities including short selling and securities financing transactions. They would also be banned from paying ratings companies to assess their creditworthiness.

The ratings ban is an attempt to “control the message” about risk in Europe and to substitute “regulatory oversight for market transparency,” Daniel Piels, a spokesman for Moody’s Investors Service Inc. in London, said in an interview.

The EU money-market fund industry is concentrated in France, Ireland, and Luxembourg. Funds domiciled in these three countries account for more than 95 percent of the EU money fund market, according to European Commission data.

Such funds hold more than a fifth of short-term debt securities issued by governments and corporates in the bloc and more than a third of short-term bank debt. The EU industry has about 1 trillion euros ($1.3 trillion) of assets under management.

Safe ‘Impression’

Funds with a fixed share price, known as constant net asset value, or CNAV funds, have come in for particular attention from regulators, as they give “an impression of safety even though money funds are subject to credit, interest rate, and liquidity risk,” the International Organization of Securities Commissions (Iosco) said last year. The failure of one fund to honor this commitment can put pressure on others and trigger runs, Iosco said.

The disorderly failure of a money-market fund could “cause broader consequences, such as contagion to the real economy and bailout risks for their sponsor and, ultimately, public authorities,” the commission said in today’s statement. “These problems can have repercussions across the European Union, since both investments in MMFs and investments by MMFs are largely performed across borders,” it said.

The International Monetary Fund and global regulators at the Financial Stability Board have urged national governments to press ahead with regulating money-market funds, identified as part of the global shadow-banking system. Iosco published a set of recommendations to regulators last year.

U.S. Rules

The EU measures, which require approval from the European Parliament and national governments to take effect, have some parallels to draft rules issued by the U.S. Securities and Exchange Commission.

The SEC has sought views on two proposals, one of which would impose a floating-share value on the riskiest money-market mutual funds, while the other would allow them to suspend redemptions in times of stress.

The EU is weighing measures such as tightening rules on re-lending or re-investment of collateral provided on securities financing transactions, and extending which kinds of firms are covered by minimum capital rules, the commission said.

Treasury & Risk

Treasury & Risk is an online publication and robust website designed to meet the information needs of finance, treasury, and risk management professionals. Our editorial content, delivered through multiple interactive channels, mixes strategic insights from thought leaders with in-depth analysis of best practices, original research projects, and case studies with corporate innovators.